The Financial Taboo

Posted in Finance Articles, Total Reads: 1941
, Published on 27 November 2011

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Yes it is a taboo for more than a billion people throughout the world. And it was a taboo for about majority of world until the medieval period. The conventional wisdom termed it taboo, the divine scriptures termed it same and even many modern scholars are saying the same. However today it exists even in smallest of financial transaction. Rather it has become an unquestionable norm in society to consider it as ‘just’ and ‘right of a lender’. Guess what it is?

Well… if you haven’t got it, it is called ‘Usury’ in medieval English, ‘Ar-Riba’ in Islamic Terminology and ‘Interest’ in modern economics (though ‘interest’ conveys only a partial meaning). Though it has become the norm of society, it is very important to reason out the conventional stance on interest/usury/riba and explore the reasons for the same. Recently there has been an increased use of this term with the debt crisis hitting countries throughout the world and especially Europe.

Has it got to do anything with the conventional wisdom? Is this the result of the taboo? Or Is Taboo an irrational argument?

We’ll try and briefly understand the other side of the story in this article. So sit back and reflect.

Starting with the most widely and generally known stance on this issue; the Islamic stance; it is mentioned in Qur’an:-

O ye who believe! Fear God, and give up what remains of your demand for Al-Riba, if you are indeed believers. If you do it not, Take notice of war from God and His Messenger. But if you turn back, you shall have your capital sums: Deal not unjustly, and you shall not be dealt with unjustly. [Qur’an 2:278-279]

It must be noted however that ‘Riba’ in Islam is much wider term compared to ‘interest & usury’; it includes them as well as various other forms of transactions. Please refer to an authentic Islamic book for the understanding the same in detail.

Then the biblical stance; a more liberal but very clear in message:-

Deuteronomy 23:19-20 reads: “Thou shalt not lend upon usury to thy brother; usury of money, usury of victuals, usury of any thing that is lent upon usury: Unto a stranger thou mayest lend upon usury; but unto thy brother thou shalt not lend upon usury: that the LORD thy God may bless thee in all that thou settest thine hand to in the land whither thou goest to possess it” (King James Version)

Though historically there have been many scholars of economics who have condemned usury/riba/interst in similar fashion, we move on to two of the most widely used logical arguments of such stance.

Argument 1:It transfers wealth from poor to rich

Amount lent at 15% yearly compound interest doubles in less than 5 years, it multiplies 10 fold every 16.5, and it multiplies 1,000 fold every 49.5years and 1,174,313 fold every 100 years. Net real rate of growth of world is below 5%. Thus in the light of this, consider following. Suppose there is 100units of money in economy and bank lends 50units through deposits at 15% annual interest, so next year bank would demand 7.5 units extra, making total money required in economy to be 107.5 units. But as already mentioned average world real GDP is less than 5%. In short, demand of money in our case would be 107.5 units whereas supply would be less than 105 units after considering growth, creating money shortage. So from where will the borrower pay his debt when money does not exist? By taking more debt/loan? For a short-term you might say others will lose their money and thus the debtor to bank will pay Rs3, but in that case you would clearly observe that within a few years all resources will end up in bank’s pocket. Also, the amount that is returned by previous borrowers is again lent on interest to new borrowers and therefore this process of doubling of dues continues despite the fact that many borrowers are able to repay the loan within a few years. And you may also consider demand for money due to bank credit creation in addition to this.

At the Macro level, such multiplying levels of money cause debt crisis or forces the government to depreciate the currency i.e. issue more currency and thereby reduce the value of each unit (which may cause inflation) and at the micro level either farmers sell their land to pay the debt or they attempt suicide. Well thu they call it a new form of colonialism Economic slavery.

When I explained this situation to Prof. Prabal Sen, who teaches economics in various top colleges like XIMR & IIM A, he agreed to the fact that, “A loan taken can never be repaid in normal scenario”. This also leads us to understand, why no country in the world (with reliable data), is operating on ZERO public debt, it’s just that governments take the burden of debt on themselves. I also recommend the documentary ‘Money as Debt’ for the issue of ‘Why debt always increases?’

Interest is the root cause of shortage of supply, unemployment, inflation and exploitation and growing disparity of income and wealth. The following example clearly demonstrates it:

Suppose that our cement factories are producing at 70% of their capacity. Now if their production is raised to 85% of capacity, then the cement price will fall (Demand-Supply Theory). Suppose that price per bag prior to and after increase in production are rupees 110 and 100 respectively. Let cost of production per bag excluding interest paid on capital borrowed prior to and after the increase in production be Rs 100 and Rs 95 respectively and the interest paid per bag is Rs8 and Rs7 respectively (Interest rate will fall slowly as capital is needed for expansion, most of the times interest payable per bag actually increases). Note that prior to increase in production the cement factories were having a net profit of rupees 2 per bag but when the production is raised there is net loss of rupees 2 per bag. This loss is due to interest, as in the absence of interest the factories would have been making a profit of rupees 5 per bag even after increasing production. Clearly, it is due to interest that the companies (who have taken loans on interest) will not increase production.

Thus, it is due to interest, that most of our industries produce far below their capacity and employ lesser labour. Due to interest, entrepreneurs can’t get capital for investment unless they are willing to pay the prevailing rate of interest. Therefore, there is no investment in a business that is not expected to produce profits much higher than the prevailing interest rate. If the interest rate is abolished, industries will be set upon profit sharing basis which will motivate entrepreneurs who will be willing to produce for lower profit margins it would increase the rate of employment, labor wage and increased production will reduce prices.

As this is an article and not a book, I would restrict the arguments to just two. However in reality there are many more, many of which I have mentioned in my book. Thus I would now like to end this article with the statements of various economists and responsible organizations on the issue on ‘impossibility of loan repayment due to interest’.

Quotes:-

United Nations Development Programme, UNDP (1998) predicted that if the external debt of the 20 poorest countries of the world was written off, it could save the lives of 20 million people before the year 2000.

Susan George stated that every year since 1981 between 15 and 20 million people died unnecessarily due to debt burden “because Third World governments have had to cut back on clean water and health programs to meet their repayments.”

In his classic essay, “Public Debts,” published in 1887, the American economist Henry Carter Adams wrote that “the granting of foreign credits is the first step toward the establishment of an aggressive foreign policy, and under certain conditions, leads inevitably to conquest and occupation.”

This article has been authored by Rahil Ahmed Khan from from XIMR. These are the personal views of the author